PINX:PCFO Pacific Office Properties Trust Inc Quarterly Report 10-Q Filing - 6/30/2012

Effective Date 6/30/2012

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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
R
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2012

OR
£
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ____________ to _____________
 
Commission file number:                                                      1-9900

PACIFIC OFFICE PROPERTIES TRUST, INC.
(Exact name of registrant as specified in its charter)
Maryland
86-0602478
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)

841 Bishop Street, Suite 1700
Honolulu, Hawaii 96813
(Address of principal executive offices) (Zip Code)

(Registrant’s telephone number, including area code):   (808) 521-7444


(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes R No £

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes R No £

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (check one):
Large accelerated filer £
   Accelerated filer £
Non-accelerated filer £
(Do not check if a smaller reporting company)
Smaller Reporting Company R

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes £ No R

APPLICABLE ONLY TO CORPORATE ISSUERS:

As of August 9, 2012 there were issued and outstanding 3,941,142 shares of Class A Common Stock, par value $0.0001 per share; 100 shares of Class B Common Stock, par value $0.0001 per share; and 2,410,839 shares of Senior Common Stock, par value $0.0001 per share.




PACIFIC OFFICE PROPERTIES TRUST, INC.
TABLE OF CONTENTS
FORM 10-Q







 


i



PART I – FINANCIAL INFORMATION

Item 1.                      Financial Statements (unaudited).

Pacific Office Properties Trust, Inc.
Consolidated Balance Sheets
(in thousands, except share and per share data)

 
June 30, 2012
 
December 31, 2011
ASSETS
 (unaudited)
 
 
Investments in real estate, net
$
225,599

 
$
281,702

Cash and cash equivalents
25,029

 
10,757

Restricted cash
5,290

 
5,897

Rents and other receivables, net
870

 
1,799

Deferred rents
3,784

 
4,951

Intangible assets, net
8,782

 
13,360

Acquired above-market leases, net
81

 
192

Other assets, net
1,139

 
2,425

Goodwill
39,111

 
48,549

Investments in unconsolidated joint ventures
4,791

 
4,980

Total assets
$
314,476

 
$
374,612

LIABILITIES AND EQUITY (DEFICIT)
 

 
 

Mortgage and other loans, net
$
297,938

 
$
356,163

Unsecured notes payable to related parties
21,104

 
21,104

Accounts payable and other liabilities
31,738

 
30,598

Acquired below-market leases, net
4,159

 
5,206

Total liabilities
354,939

 
413,071

Commitments and contingencies (Note 10)


 


Equity (cumulative deficit):
 

 
 

Preferred Stock, $0.0001 par value per share, 100,000,000 shares authorized, one share of Proportionate Voting Preferred Stock issued and outstanding at June 30, 2012 and December 31, 2011

 

Senior Common Stock, $0.0001 par value per share (liquidation preference $10 per share, $24,108 as of June 30, 2012 and December 31, 2011) 40,000,000 shares authorized, 2,410,839 shares issued and outstanding at June 30, 2012 and December 31, 2011
21,459

 
21,459

Class A Common Stock, $0.0001 par value per share, 599,999,900 shares authorized, 3,941,142 shares issued and outstanding at June 30, 2012 and December 31, 2011
185

 
185

Class B Common Stock, $0.0001 par value per share, 100 shares authorized, issued and outstanding at June 30, 2012 and December 31, 2011

 

Additional paid-in capital
110

 
110

Cumulative deficit
(156,598
)
 
(156,160
)
Total stockholders’ equity (deficit)
(134,844
)
 
(134,406
)
Non-controlling interests:
 

 
 

Preferred unitholders in the Operating Partnership
127,268

 
127,268

Common unitholders in the Operating Partnership
(32,887
)
 
(31,321
)
Total equity (deficit)
(40,463
)
 
(38,459
)
Total liabilities and equity (deficit)
$
314,476

 
$
374,612


See accompanying notes to consolidated financial statements.

1



Pacific Office Properties Trust, Inc.
Consolidated Statements of Operations
(in thousands, except share and per share data)
(unaudited)
 
 
For the three months ended
 
June 30,
 
2012
 
2011
Revenue:
 
 
 
Rental
$
5,812

 
$
7,087

Tenant reimbursements
4,001

 
3,905

Property management and other services
114

 
1,591

Parking
1,440

 
1,506

Other
135

 
299

Total revenue
11,502

 
14,388

Expenses:
 

 
 

Rental property operating
7,272

 
7,485

General and administrative
572

 
3,067

Depreciation and amortization
2,937

 
3,460

Interest
5,007

 
5,337

Acquisition costs

 
68

Impairment on long-lived assets

 
11,456

Total expenses
15,788

 
30,873

Loss from continuing operations before gain on forgiveness of debt, equity in net earnings (loss) of unconsolidated joint ventures and non-operating income
(4,286
)
 
(16,485
)
Gain on forgiveness of debt

 
10,045

Equity in net earnings (loss) of unconsolidated joint ventures
22

 
(1,490
)
Non-operating income

 
(17
)
Net loss from continuing operations
(4,264
)
 
(7,947
)
Discontinued operations:
 
 
 
Income (loss) from discontinued operations before gain on sale of property
542

 
(3,577
)
Gain on sale of property
5,365

 

Income (loss) from discontinued operations
5,907

 
(3,577
)
 
 
 
 
Net income (loss)
1,643

 
(11,524
)
Net (income) loss attributable to non-controlling interests:
 

 
 

Preferred unitholders in the Operating Partnership
(568
)
 
(568
)
Common unitholders in the Operating Partnership
(498
)
 
9,811

 
(1,066
)
 
9,243

Dividends on Senior Common Stock
(438
)
 
(438
)
Net income (loss) attributable to common stockholders
$
139

 
$
(2,719
)
 
 
 
 
Income (loss) per common share:
 
 
 
Loss from continuing operations
$
(0.29
)
 
$
(0.50
)
Income (loss) from discontinued operations
0.33

 
(0.20
)
Net income (loss) per common share - basic and diluted
$
0.04

 
$
(0.70
)
 
 

 
 

Weighted average number of common shares
outstanding - basic and diluted
3,941,242

 
3,909,429


See accompanying notes to consolidated financial statements.


2



Pacific Office Properties Trust, Inc.
Consolidated Statements of Operations
(in thousands, except share and per share data)
(unaudited)
 
 
For the six months ended
 
June 30,
 
2012
 
2011
Revenue:
 
 
 
Rental
$
11,670

 
$
16,090

Tenant reimbursements
7,991

 
8,253

Property management and other services
1,408

 
2,353

Parking
2,817

 
3,264

Other
323

 
866

Total revenue
24,209

 
30,826

Expenses:
 

 
 

Rental property operating
13,947

 
16,082

General and administrative
3,276

 
5,634

Depreciation and amortization
5,861

 
7,717

Interest
9,961

 
11,708

Abandoned offering costs

 
420

Acquisition costs

 
267

Impairment on long-lived assets

 
11,456

Total expenses
33,045

 
53,284

Loss from continuing operations before gain on forgiveness of debt, equity in net earnings (loss) of unconsolidated joint ventures and non-operating income
(8,836
)
 
(22,458
)
Gain on forgiveness of debt

 
10,045

Equity in net earnings (loss) of unconsolidated joint ventures
527

 
(1,394
)
Non-operating income

 
507

Net loss from continuing operations
(8,309
)
 
(13,300
)
Discontinued operations:
 
 
 
Income (loss) from discontinued operations before gains on extinguishment of debt and sale of property
700

 
(3,642
)
Gain on extinguishment of debt
2,251

 

Gain on sale of property
5,365

 

Income (loss) from discontinued operations
8,316

 
(3,642
)
 
 
 
 
Net income (loss)
7

 
(16,942
)
Net (income) loss attributable to non-controlling interests:
 

 
 

Preferred unitholders in the Operating Partnership
(1,136
)
 
(1,136
)
Common unitholders in the Operating Partnership
1,566

 
14,842

 
430

 
13,706

Dividends on Senior Common Stock
(875
)
 
(875
)
Net loss attributable to common stockholders
$
(438
)
 
$
(4,111
)
 
 
 
 
Income (loss) per common share:
 
 
 
Loss from continuing operations
$
(0.57
)
 
$
(0.85
)
Income (loss) from discontinued operations
$
0.46

 
$
(0.20
)
Net loss per common share - basic and diluted
$
(0.11
)
 
$
(1.05
)
 
 

 
 

Weighted average number of common shares
outstanding - basic and diluted
3,941,242

 
3,906,307


See accompanying notes to consolidated financial statements.

3



Pacific Office Properties Trust, Inc.
Consolidated Statements of Cash Flows
(in thousands and unaudited)
 
For the six months ended
 
June 30,
 
2012
 
2011
Operating activities
 
 
 
Net income (loss)
$
7

 
$
(16,942
)
Net income (loss) from discontinued operations
8,316

 
(3,642
)
Net loss from continuing operations
(8,309
)
 
(13,300
)
Adjustments to reconcile net income (loss) to net cash provided by operating activities - continuing operations:
 

 
 

Depreciation and amortization
5,861

 
7,716

Impairment of long-lived assets

 
11,456

Gain on forgiveness of debt

 
(10,045
)
Gain on internalization of Pacific Office Management

 
(507
)
Deferred rent
(38
)
 
196

Deferred ground rents
1,025

 
1,041

Interest amortization
1,162

 
1,366

Share based compensation

 
60

Above- and below-market lease amortization, net
(132
)
 
(605
)
Equity in net earnings (loss) of unconsolidated joint ventures
(527
)
 
1,394

Bad debt expense
433

 
162

Changes in operating assets and liabilities:


 


Restricted cash
(603
)
 
4,007

Rents and other receivables
353

 
(197
)
Other assets
742

 
1,646

Accounts payable and other liabilities
(22
)
 
(2,105
)
Net cash (used in) provided by operating activities - continuing operations
(55
)
 
2,285

Net cash provided by operating activities - discontinued operations
1,026

 
184

Net cash provided by operating activities
971

 
2,469

Investing activities
 

 
 

Additions to and improvement of real estate
(7,537
)
 
(2,336
)
Investment in unconsolidated joint ventures

 
(2,375
)
Acquisition of Pacific Office Management, net of cash received

 
293

Distributions from unconsolidated joint ventures
838

 
940

Contributions to unconsolidated joint ventures
(121
)
 
(125
)
Net sales proceeds from sale of property
17,298

 

Payment of leasing commissions
(314
)
 
(450
)
Interim financing provided to unconsolidated joint venture

 
(600
)
Increase in restricted cash used for capital expenditures
(216
)
 
872

Net cash provided by (used in) investing activities
$
9,948

 
$
(3,781
)

4



 
For the six months ended
 
June 30,
 
2012
 
2011
Financing activities
 

 
 

Repayment of mortgage notes payable
$
(232
)
 
$
(208
)
Proceeds from mortgage note payable
4,875

 

Borrowings from revolving credit facility

 
553

Senior Common Stock repurchase

 
(34
)
Financing costs

 
(1,558
)
Payment on settlement of debt
(415
)
 

Security deposits

 
(78
)
Senior Common Stock dividends
(875
)
 
(860
)
Class A Common Stock dividends

 
(43
)
Distributions to non-controlling interests - Preferred unitholders

 
(568
)
Distributions to non-controlling interests - Common unitholders

 
(155
)
Net cash provided by (used in) financing activities
3,353

 
(2,951
)
Increase (decrease) in cash and cash equivalents
14,272

 
(4,263
)
Cash and cash equivalents at beginning of period
10,757

 
9,112

Cash and cash equivalents at end of period
$
25,029

 
$
4,849

 
 
 
 
Supplemental cash flow information
 

 
 

Interest paid
$
10,753

 
$
10,570

 
 
 
 
Supplemental disclosure of non-cash investing and financing activities
 

 
 

Accrued dividends and distributions
$
1,136

 
$
1,136

Change in accrued capital expenditures
$
221

 
$
(1,018
)
 

See accompanying notes to consolidated financial statements.

5




Pacific Office Properties Trust, Inc.
Notes to Consolidated Financial Statements
(unaudited)

1. Organization and Ownership

Pacific Office Properties -

The terms “Pacific Office Properties,” “us,” “we,” and “our” as used in this Quarterly Report on Form 10-Q refer to Pacific Office Properties Trust, Inc., a Maryland corporation (the “Company”), and its subsidiaries and joint ventures. Through our controlling interest in Pacific Office Properties, L.P. (the “Operating Partnership”), of which we are the sole general partner, and the subsidiaries of the Operating Partnership, we own and operate primarily institutional-quality office properties in Hawaii. We operate in a manner that permits us to satisfy the requirements for taxation as a real estate investment trust (“REIT”) under the Internal Revenue Code of 1986 (the “Code”).

During January 2011, we were externally advised by Pacific Office Management, Inc., a Delaware corporation (“Pacific Office Management”), an entity that was owned and controlled by Jay H. Shidler (“Mr. Shidler”), our Chairman of the Board, certain of our current and former executive officers and James C. Reynolds, who beneficially owns approximately 12% of our Class A Common Stock. Pacific Office Management was responsible for our day-to-day operation and management. Effective as of February 1, 2011, we acquired all of the outstanding stock of Pacific Office Management and internalized management. From February 1, 2011 through March 31, 2012, we remained self-managed.

Effective April 1, 2012, we became externally advised once again. Our advisor is Shidler Pacific Advisors, LLC (“Shidler Pacific Advisors”), an entity that is owned and controlled by Mr. Shidler. Lawrence J. Taff, formerly our Executive Vice President and now our President, Chief Executive Officer, Chief Financial Officer and Treasurer effective as of March 29, 2012, also serves as President of Shidler Pacific Advisors. Shidler Pacific Advisors is responsible for the day-to-day operation and management of the Company. In addition, effective April 1, 2012, all of our wholly-owned properties are managed by Shidler Pacific Advisors and all of our joint venture properties are managed by Parallel Capital Partners, Inc. (“Parallel Capital Partners”), an entity owned by James R. Ingebritsen, our former Chief Executive Officer; Matthew J. Root, our former Chief Investment Officer; and Mr. Reynolds, all of whom combined, beneficially own approximately 22% of our Class A Common Stock.

Through our Operating Partnership, as of June 30, 2012, we owned 4 office properties comprising approximately 1.2 million rentable square feet and interests (ranging from 5.0% to approximately 32.2%) in 16 joint venture properties (including a sports club associated with our City Square property in Phoenix, Arizona), of which we have managing ownership interests in 13, comprising approximately 2.5 million rentable square feet (the “Property Portfolio”).  As of June 30, 2012, our Property Portfolio included office buildings in Honolulu, San Diego, Orange County, certain submarkets of Los Angeles and Phoenix.  

2. Summary of Significant Accounting Policies

Basis of Presentation

The accompanying consolidated financial statements and related disclosures included herein have been prepared in accordance with United States generally accepted accounting principles (“GAAP”).

Certain amounts in the consolidated financial statements for prior periods have been reclassified to conform to the current period presentation with no corresponding net effect on the previously reported consolidated results of operations, or financial position of the Company.
 
Principles of Consolidation

The accompanying consolidated financial statements include the account balances and transactions of consolidated subsidiaries, which are wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.

Use of Estimates in Financial Statements

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial

6

Pacific Office Properties Trust, Inc.
Notes to Consolidated Financial Statements



statements and the reported amounts of revenues and expenses during the reported periods. Actual results could differ from those estimates.
 
Liquidity

Our business is capital intensive and our ability to maintain our operations depends on our cash flow from operations and our ability to raise additional capital on acceptable terms.  Our primary focus is to preserve and generate cash.

We expect to meet our short-term liquidity and capital requirements primarily through existing cash on hand, net cash provided by operating activities, the contribution of additional existing wholly-owned assets to joint ventures or asset dispositions. We expect to meet our long-term capital requirements through net cash provided by operating activities, borrowings under our revolving credit facility (if available), refinancing of existing debt or through other available investment and financing activities, including the contribution of existing wholly-owned assets to joint ventures (partial sell-down of equity interests in wholly-owned assets) or asset dispositions.  In June 2012, we received approximately $17.3 million of net proceeds related to the completion of the sale of our fee and leasehold interests in the First Insurance Center property. The Bank of Hawaii Waikiki Center joint venture property is currently being marketed for sale.

We are focused on ensuring our properties are operating as efficiently as possible.  We have taken steps to identify opportunities to reduce discretionary operating costs wherever possible and at the same time maintaining the quality of our buildings and the integrity of our management services. 

As previously mentioned, effective April 1, 2012, we became externally advised by Shidler Pacific Advisors. In addition, effective April 1, 2012, all of our wholly-owned properties are managed by Shidler Pacific Advisors and all of our joint venture properties are managed by Parallel Capital Partners. Our return to external management and related actions reflect our determination to reduce costs as much as reasonably practicable in the near future. This streamlining reduced the full-time workforce previously dedicated to our investment, divestment and capital markets activities. We do not expect to pursue these activities in the near future. We therefore believe that Shidler Pacific Advisors and Parallel Capital Partners can provide adequate personnel resources, at lower cost to us, for our current and prospective business. We expect to require additional personnel if we resume substantial activities of this nature.

Capital expenditures fluctuate in any given period, subject to the nature, extent and timing of improvements required to maintain our properties. Leasing costs also fluctuate in any given period, depending upon such factors as the type of property, the term of the lease, the type of lease and overall market conditions. Our costs for capital expenditures and leasing fall into two categories: (1) amounts that we are contractually obligated to spend and (2) discretionary amounts.  We currently expect to spend approximately $2.6 million in committed capital expenditures and leasing costs during the remainder of 2012.  We are currently focused on preserving cash and intend to limit the amount of discretionary funds allocated to capital expenditures and leasing costs in the near term.  This may result in a decrease in average rental rates and the number of new leases we execute, which would adversely affect our cash flow generated from operations.

As of June 30, 2012, our total consolidated debt (which includes our mortgage and other loans, with a carrying value of $298.6 million and our unsecured promissory notes with a carrying value of $21.1 million) was approximately $319.7 million, with a weighted average interest rate of 5.77% and a weighted average remaining term of 3.84 years.

We have no consolidated debt that matures in 2012. As of December 31, 2011, we had $11.6 million in principal indebtedness secured by the Sorrento Technology Center property that was in default. On June 6, 2011, we received a notice of default from the lender of this loan asserting our failure to pay all amounts when due thereunder.  The lender subsequently foreclosed on the loan on January 5, 2012, and took back the property.

While we may be able to anticipate and plan for certain liquidity needs, there may be unexpected increases in uses of cash that are beyond our control and which would affect our financial condition and results of operations. For example, we may be required to comply with new laws or regulations that cause us to incur unanticipated capital expenditures for our properties, thereby increasing our liquidity needs. Even if there are no material changes to our anticipated liquidity requirements, our sources of liquidity may be fewer than, and the funds available from such sources may be less than, anticipated or needed.  
 
Investments in Real Estate
 
We account for acquisitions of real estate utilizing the purchase method and, accordingly, the results of operations of acquired

7

Pacific Office Properties Trust, Inc.
Notes to Consolidated Financial Statements



properties are included in our results of operations from the respective dates of acquisition.
 
Investments in real estate properties are stated at cost, less accumulated depreciation and amortization. A portion of certain assets comprising the properties contributed at the time of our formation transactions (the “Contributed Properties”) are stated at their historical net cost basis in an amount attributable to the ownership interests in the Contributed Properties owned by Mr. Shidler. Additions to land, buildings and improvements, furniture, fixtures and equipment and construction in progress are recorded at cost.
 
Transaction costs related to acquisitions are expensed. Costs associated with developing space for its intended use are capitalized and amortized over their estimated useful lives, commencing at the later of the improvement completion date or the lease commencement date.

Estimates of future cash flows and other valuation techniques are used to allocate the acquisition cost of acquired properties among land, buildings and improvements, and identifiable intangible assets and liabilities such as amounts related to in-place at-market leases, acquired above- and below-market leases, and acquired above- and below-market ground leases.

The fair values of real estate assets acquired are determined on an “as-if-vacant” basis. The “as-if-vacant” fair value is allocated to land, and where applicable, buildings, tenant improvements and equipment based on comparable sales and other relevant information obtained in connection with the acquisition of the property.
 
Fair value is assigned to above-market and below-market leases based on the difference between (a) the contractual amounts to be paid by the tenant based on the existing lease and (b) management’s estimate of current market lease rates for the corresponding in-place leases, over the remaining terms of the in-place leases. Capitalized above- and below-market lease amounts are reflected in “Acquired above-market leases, net” and “Acquired below-market leases, net,” respectively, in the consolidated balance sheets. Capitalized above-market lease amounts are amortized as a decrease to rental revenue over the remaining initial non-cancellable lease terms plus the terms of any below-market fixed rate renewal options that are considered bargain renewal options. Capitalized below-market lease amounts are amortized as an increase in rental revenue over the remaining initial non-cancellable lease terms plus the terms of any below-market fixed rate renewal options that are considered bargain renewal options. If a tenant vacates its space prior to the contractual termination of the lease and no rental payments are being made on the lease, any unamortized balance, net of the security deposit, of the related intangible is written off.
 
Fair value is also assigned to tenant relationships.  Capitalized tenant relationship amounts are included in “Intangible assets” in the accompanying consolidated balance sheets and are amortized to “Depreciation and amortization” in the accompanying consolidated statements of operations.  Amounts are amortized over the remaining terms of the respective leases even if a tenant vacates prior to the contractual termination of the lease.  An adjustment to tenant relationship amounts occurs should the property experience an impairment loss.

The aggregate value of other acquired intangible assets consists of acquired in-place leases. The fair value allocated to acquired in-place leases consists of a variety of components including, but not necessarily limited to: (a) the value associated with avoiding the cost of originating the acquired in-place lease (i.e. the market cost to execute a lease, including leasing commissions and legal fees, if any); (b) the value associated with lost revenue related to tenant reimbursable operating costs estimated to be incurred during the assumed lease-up period (i.e. real estate taxes, insurance and other operating expenses); (c) the value associated with lost rental revenue from existing leases during the assumed lease-up period; and (d) the value associated with any other inducements to secure a tenant lease. The value assigned to acquired in-place leases is amortized over the remaining lives of the related leases.
 
We record the excess of the cost of an acquired entity over the net of the amounts assigned to assets acquired (including identified intangible assets) and liabilities assumed as goodwill. Goodwill is not amortized but is tested for impairment at a level of reporting referred to as a reporting unit on an annual basis, during the fourth quarter of each calendar year, or more frequently, if events or changes in circumstances indicate that the asset might be impaired. An impairment loss for an asset group is allocated to the long-lived assets of the group on a pro-rata basis using the relative carrying amounts of those assets, except that the loss allocated to an individual long-lived asset shall not reduce the carrying amount of that asset below its fair value. A description of our testing policy is set forth in “Impairment of Long-Lived Assets” below.

Impairment of Long-Lived Assets

In accordance with the provisions of the Impairment or Disposal of Long-Lived Assets Subsections of Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 360, Property, Plant and Equipment, we assess the

8

Pacific Office Properties Trust, Inc.
Notes to Consolidated Financial Statements



potential for impairment of our long-lived assets, including real estate properties, whenever events occur or a change in circumstances indicate that the recorded carrying value might not be fully recoverable. Indicators of potential impairment include significant decreases in occupancy levels and/or rental rates or a change in strategy that results in a decreased holding period. We determine whether impairment in value has occurred by comparing the estimated future cash flows, undiscounted and excluding interest, expected from the use and eventual disposition of the asset to its carrying value. If the undiscounted cash flows do not exceed the carrying value, the real estate or intangible carrying value is reduced to fair value and impairment loss is recognized. Assets to be disposed of are reported at the lower of the carrying amount or fair value, less costs to sell. No impairment charges for our wholly-owned properties were recorded for the three and six months ended June 30, 2012. In the second quarter of 2011, we recorded non-cash asset impairment charges of approximately $3.3 million on our Sorrento Technology Center property after concluding the carrying value may not be fully recoverable upon defaulting on our loan secured by the property. The operating results of the Sorrento property have been reclassified to “Discontinued operations,” for the reporting periods presented, in the accompanying consolidated financial statements of operations. Also in the second quarter of 2011, we recorded non-cash impairment charges of approximately $5.1 million and $6.4 million on our Pacific Business News Building and City Square properties, respectively, as a result of contributing these properties into joint ventures with a third party based on fair values below their current carrying values.

Investments in Unconsolidated Joint Ventures

Our investments in joint ventures are accounted for under the equity method of accounting because we exercise significant influence over, but do not control, our joint ventures.  Our joint venture partners have substantive participating rights, including approval of and participation in setting operating budgets.  Accordingly, we have determined that the equity method of accounting is appropriate for our investments in joint ventures.

Investments in unconsolidated joint ventures are initially recorded at cost and are subsequently adjusted for our proportionate equity in the net income or net loss of the joint ventures, contributions made to, or distributions received from, the joint ventures and other adjustments.  We record distributions of operating profit from our investments in unconsolidated joint ventures as part of cash flows from operating activities and distributions related to a capital transaction, such as a refinancing transaction or sale, as investing activities in the consolidated statements of cash flows.  

The difference between the initial cost of the investment in our joint ventures included in our consolidated balance sheet and the underlying equity in net assets of the respective joint ventures (“JV Basis Differential”) is amortized as an adjustment to equity in net income or net loss of the joint ventures in our consolidated statement of operations over the estimated useful lives of the underlying assets of the respective joint ventures.

We evaluate all investments in accordance with the guidance of FASB Accounting Standards Update 2009-17, Consolidations (Topic 810): Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities, which was effective January 1, 2010 and which requires ongoing assessments of the investments to determine whether or not they are variable interest entities (“VIEs”) and if they are VIEs, whether or not we are determined to be the primary beneficiary. We would consolidate a VIE if it is determined that we are the primary beneficiary. We use qualitative analyses to determine whether we are the primary beneficiary of a VIE. Consideration of various factors could include, but is not limited to, the purpose and design of the VIE, risks that the VIE was designed to create and pass through, the form of our ownership interest, our representation of the entity’s governing body, the size and seniority of our investment, our ability to participate in policy making decisions, and the rights of the other investors to participate in the decision making process and to replace us as manager and/or liquidate the venture, if applicable.  We currently do not hold any investments in VIEs.

Impairment of Investments in Unconsolidated Joint Ventures
 
Our investment in unconsolidated joint ventures is subject to a periodic impairment review and is considered to be impaired when a decline in fair value is judged to be other-than-temporary. An investment in an unconsolidated joint venture that we identify as having an indicator of impairment is subject to further analysis to determine if the investment is other than temporarily impaired, in which case we write down the investment to its estimated fair value. No impairment charges were recorded for the three and six months ended June 30, 2012. In the second quarter of 2011, we recorded a non-cash impairment charge of approximately $1.4 million to write off our investment in the unconsolidated joint venture that owns the US Bank property as a result of uncertainty surrounding the debt secured by the property.


9

Pacific Office Properties Trust, Inc.
Notes to Consolidated Financial Statements



Discontinued Operations

The revenue, expenses, impairment and/or gain on sale of operating properties that meet the applicable criteria are reported as discontinued operations in the consolidated statement of operations. A gain on sale, if any, is recognized in the period the property is disposed of.

In determining whether to report the results of operations, impairment and/or gain on sale of operating properties as discontinued operations, we evaluate whether we have any significant continuing involvement in the operations, leasing or management of the property after disposition. If we determine that we have significant continuing involvement after disposition, we report the revenue, expenses, impairment and/or gain on sale as part of continuing operations.

We classify properties as held for sale when certain criteria set forth in the Long-Lived Assets Classified as Held for Sale Subsections of FASB ASC 360, Property, Plant and Equipment, are met. At that time, we present the non-cash assets and liabilities of the property held for sale separately in our consolidated balance sheet. We cease recording depreciation and amortization expense at the time a property is classified as held for sale. Properties held for sale are reported at the lower of their carrying amount or their estimated fair value, less estimated costs to sell. In June 2012, we completed the sale of our fee and leasehold interests in the First Insurance Center. Accordingly, the associated assets and liabilities have been removed from our consolidated balance sheet and the results of its operations before the sale for the periods ended June 30, 2012 and 2011, including the gain on the sale of the property, are included in “Discontinued operations” in the accompanying consolidated statements of operations.

Properties in default do not meet the criteria to be held for sale as they are expected to be disposed of other than by sale. Accordingly, the assets and liabilities of properties in default are included in our consolidated balance sheets and their results of operations are presented as part of continuing operations in the consolidated statements of operations for all periods presented. The assets and liabilities of these properties will be removed from our consolidated balance sheet and the results of operations will be reclassified to discontinued operations in our consolidated statements of operations upon the ultimate disposition of each property. On January 5, 2012, the lender foreclosed on the loan secured by the Sorrento Technology Center property and took back the property. Accordingly, the associated assets and liabilities have been removed from our consolidated balance sheet and the results of operations have been reclassified to discontinued operations for the periods ended June 30, 2012 and 2011.

Goodwill
 
We record the excess cost of an acquired entity over the net of the amounts assigned to assets acquired (including identified intangible assets) and liabilities assumed as goodwill. Goodwill is not amortized but is tested for impairment on an annual basis during the fourth quarter of each calendar year, or more frequently if circumstances indicate that a possible impairment has occurred. The assessment of impairment involves a two-step process whereby an initial assessment for potential impairment is performed, followed by a measurement of the amount of impairment, if any. Impairment testing is performed using the fair value approach, which requires the use of estimates and judgment, at the “reporting unit” level. A reporting unit is the operating segment, or a business that is one level below the operating segment if discrete financial information is prepared and regularly reviewed by management at that level.   The reporting unit’s fair value is calculated as the discounted future cash flows based on management’s best estimate of the applicable capitalization and discount rates. If the carrying value of a reporting unit exceeds its fair value, the second step of the goodwill impairment test is performed to measure the amount of impairment loss, if any. An impairment charge is recognized as a charge against income equal to the excess of the carrying value of goodwill over its implied value on the date of the impairment.  Factors that may cause goodwill to be impaired include, but may not be limited to, a sustained decline in our stock price and the occurrence, or sustained existence, of adverse economic conditions or decreased cash flow from our properties.
 
We had previously identified three reporting units to which goodwill was allocated.  Our consolidated properties in Hawaii are considered one reporting unit due to similar geographic and economic characteristics. Our City Square and Sorrento Technology Center properties were considered to be their own respective reporting units due to their respective locations in Phoenix, Arizona and San Diego, California, two distinct markets. All of the goodwill associated with the Phoenix and San Diego reporting units was written off during the year ended December 31, 2010. As of June 30, 2012, the goodwill of the Hawaii reporting unit amounted to $39.1 million, after writing off approximately $9.4 million of goodwill associated with the sale of the First Insurance Center property in June 2012.

Revenue Recognition
 
The following four criteria must be met before we recognize revenue and gains:
 

10

Pacific Office Properties Trust, Inc.
Notes to Consolidated Financial Statements



persuasive evidence of an arrangement exists;
the delivery has occurred or services rendered;
the fee is fixed and determinable; and
collectability is reasonably assured.

All of our tenant leases are classified as operating leases. For all leases with scheduled rent increases or other adjustments, minimum rental income is recognized on a straight-line basis over the terms of the related leases. Straight-line rent receivable represents rental revenue recognized on a straight-line basis in excess of billed rents and this amount is included in “Deferred rents” on the accompanying consolidated balance sheets. The straight line rent adjustment included in “Rental revenues” in the accompanying consolidated statements of operations was $(0.01) million and ($0.03) million for the three months ended June 30, 2012 and 2011, respectively, and $0.03 million and ($0.20) million for the six months ended June 30, 2012 and 2011, respectively.  Reimbursements from tenants for real estate taxes, excise taxes and other recoverable operating expenses are recognized as revenues in the period the applicable costs are incurred.
 
Capitalized above-market and below-market lease amounts are amortized as a decrease and increase, respectively, to rental revenue over the remaining initial non-cancelable lease terms plus the terms of any below-market fixed rate renewal options that are considered bargain renewal options.

We have leased space to certain tenants under non-cancelable operating leases, which provide for percentage rents based upon tenant revenues. Percentage rental income is recorded in “Rental revenues” in the accompanying consolidated statements of operations.
 
Rental revenue from parking operations and month-to-month leases or leases with no scheduled rent increases or other adjustments is recognized on a monthly basis when earned.
 
Lease termination fees, net of the write-off of associated intangible assets and liabilities and straight-line rent balances which are included in “Other revenues” of the accompanying consolidated statements of operations, are recognized when the related leases are canceled and we have no continuing obligation to provide services to such former tenants.

Other revenue on the accompanying consolidated statements of operations generally includes income incidental to our operations and is recognized when earned.

Tenant Receivables

Tenant receivables are recorded and carried at the amount billable per the applicable lease agreement, less any allowance for doubtful accounts. An allowance for doubtful accounts is made when collection of the full amounts is no longer considered probable. Tenant receivables are included in “Rents and other receivables, net,” in the accompanying consolidated balance sheets. If a tenant fails to make contractual payments beyond any allowance, we may recognize bad debt expense in future periods equal to the amount of unpaid rent and deferred rent. We take into consideration factors including historical termination, default activity and current economic conditions to evaluate the level of reserve necessary. We had an allowance for doubtful accounts of $0.8 million and $0.4 million as of June 30, 2012 and December 31, 2011, respectively.

We had a total of approximately $1.8 million and $1.9 million of lease security available in security deposits, as of June 30, 2012 and December 31, 2011, respectively.

Cash and Cash Equivalents

We consider all short-term cash investments with maturities of three months or less when purchased to be cash equivalents. Restricted cash is excluded from cash and cash equivalents for the purpose of preparing our consolidated statements of cash flows.

We maintain cash balances in various financial institutions. At times, the amounts of cash held in financial institutions may exceed the maximum amount insured by the Federal Deposit Insurance Corporation. We do not believe that we are exposed to any significant credit risk on our cash and cash equivalents.

Restricted Cash

Restricted cash includes escrow accounts for real property taxes, insurance, capital expenditures and tenant improvements,

11

Pacific Office Properties Trust, Inc.
Notes to Consolidated Financial Statements



debt service and leasing costs held by lenders.  
 
Mortgage and Other Loans

Mortgage and other loans assumed upon acquisition of related real estate properties are stated at estimated fair value upon their respective dates of assumption, net of unamortized discounts or premiums to their outstanding contractual balances. Amortization of discount and the accretion of premiums on mortgage and other loans assumed upon acquisition of related real estate properties are recognized from the date of assumption through their contractual maturity date using the straight line method, which approximates the effective interest method.

Deferred Loan Fees

Deferred loan fees include fees and costs incurred in conjunction with long-term financings and are amortized over the terms of the related debt using a method that approximates the interest method. Deferred loan fees are included in “Other assets, net” in the accompanying consolidated balance sheets.  Amortization of deferred loan fees is included in “Interest” in the accompanying consolidated statements of operations.

Repairs, Maintenance and Major Improvements

The costs of ordinary repairs and maintenance are included when incurred in “Rental property operating” expenses in the accompanying consolidated statements of operations. Major improvements that extend the life of an asset are capitalized and depreciated over the remaining useful life of the asset. Various lenders have required us to maintain reserve accounts for the funding of future repairs and capital expenditures, and the balances of these accounts are included in “Restricted cash” on the accompanying consolidated balance sheets.

Leasing Commissions

Leasing commissions are capitalized and amortized on a straight line basis over the life of the related lease.  The payment of leasing commissions is included in “Investing activities” on the accompanying consolidated statement of cash flows because we believe that paying leasing commissions for good tenants is a prudent investment in increasing the value of our income-producing assets.

Depreciation and Amortization

Depreciation and amortization are computed using the straight-line method for financial reporting purposes. Buildings and improvements are depreciated over their estimated useful lives which range from 5 to 42 years. Tenant improvement costs recorded as capital assets are depreciated over the shorter of the tenant’s remaining lease term or the life of the improvement. Furniture, fixtures and equipment are depreciated over 3 to 7 years.  Properties that are acquired that are subject to ground leases are depreciated over the lesser of the useful life or the remaining life of the related leases as of the date of assumption of the lease.

Equity Offering Costs

Costs from potential equity offerings are reflected in “Other assets, net” in the accompanying consolidated balance sheets and are reclassified as a reduction in additional paid-in capital if and when the offering is successfully completed.  Costs include legal, accounting, marketing and other professional fees associated with the offering.  If an equity offering is abandoned or delayed for more than 90 days, the costs recorded on the balance sheet are expensed.  During the six months ended June 30, 2012 and 2011, we expensed $0 and $0.4 million, respectively, in costs related to our unsuccessful public offering of Class A Common Stock. 
 
Stock-Based Compensation

All share-based payments to employees, including directors, are recognized in the consolidated statement of operations based on their fair values.  We recognize share-based compensation in accordance with FASB ASC 718, Compensation—Stock Compensation. In accordance with FASB ASC 718, we determine the fair value of the share-based compensation grants on the respective grant dates, and recognize to expense the fair value of the grants over the employees’ or directors’ requisite service periods, which are generally the vesting periods. If the grants vest immediately, we expense the fair value of the grant in full on the grant date. The fair value of the share-based payment awards are generally based on the Company’s Class A Common Stock

12

Pacific Office Properties Trust, Inc.
Notes to Consolidated Financial Statements



price on the date of grant.  See Note 14 for a more detailed discussion.

Non-Controlling Interests

We account for non-controlling interests in accordance with FASB ASC 810, Consolidation. In accordance with FASB ASC 810, we report non-controlling interests in subsidiaries within equity in the consolidated financial statements, but separate from the parent stockholders’ equity. Net income attributable to non-controlling interests is presented as a reduction from net income in calculating net income available to common stockholders on the statement of operations.  Acquisitions or dispositions of non-controlling interests that do not result in a change of control are accounted for as equity transactions. In addition, FASB ASC 810 requires that a parent company recognize a gain or loss in net income when a subsidiary is deconsolidated upon a change in control. In accordance with FASB ASC 480-10, Distinguishing Liabilities from Equity, non-controlling interests that are determined to be redeemable are carried at their redemption value as of the balance sheet date and reported as temporary equity. We periodically evaluate individual non-controlling interests for the ability to continue to recognize the non-controlling interest as permanent equity in the consolidated balance sheets. Any non-controlling interest that fails to qualify as permanent equity will be reclassified as temporary equity and adjusted to the greater of (a) the carrying amount, or (b) its redemption value as of the end of the period in which the determination is made, the resulting adjustment is recorded in the consolidated statement of operations. See Note 11 for a more detailed discussion.

Preferred Units

The Class A convertible preferred units of the Operating Partnership (“Preferred Units”) have fixed rights to distributions at an annual rate of 2% of their liquidation preference of $25 per Preferred Unit. Accordingly, income or loss of the Operating Partnership is allocated among the general partner interest and limited partner common interests after taking into consideration distribution rights allocable to the Preferred Units.  

Earnings (Loss) per Share

We present both basic and diluted earnings (loss) per share (“EPS”).  Basic EPS is computed by dividing net income (loss) available to common stockholders by the weighted average number of common shares outstanding during each period.

Diluted EPS is computed by dividing net income (loss) available to common stockholders for the period by the weighted average number of common shares that would have been outstanding for the period, assuming the issuance of common shares for all potentially dilutive common shares outstanding during such period.

Income Taxes

We have elected to be taxed as a REIT under the Code. To qualify as a REIT, we must meet a number of organizational and operational requirements, including a requirement that we currently distribute at least 90% of our REIT taxable income to our stockholders.  Also, at least 95% of gross income in any year must be derived from qualifying sources.  We intend to adhere to these requirements and maintain our REIT status. As a REIT, we generally will not be subject to corporate level federal income tax on taxable income that we distribute currently to our stockholders.  However, we may be subject to certain state and local taxes on our income and property, and to federal income and excise taxes on our undistributed taxable income, if any.  Management believes that we have distributed and will continue to distribute a sufficient majority of our taxable income, if any, in the form of dividends and distributions to our stockholders and unit holders.  Accordingly, we have not recognized any provision for income taxes.
 
Pursuant to the Code, we may elect to treat certain of our newly created corporate subsidiaries as taxable REIT subsidiaries (“TRS”).  In general, a TRS may perform non-customary services for our tenants, hold assets that we cannot hold directly and generally engage in any real estate or non-real estate related business.  A TRS is subject to corporate federal income tax.  As of June 30, 2012, Pacific Office Management had elected to be treated as a TRS for federal income tax purposes.
 
Recent Accounting Pronouncements
 
In June 2011, the FASB issued ASU No. 2011-05, Presentation of Comprehensive Income (“ASU 2011-05”), which amended ASC Topic 220, Comprehensive Income. ASU 2011-05 eliminates the option to present components of other comprehensive income as part of the statement of changes in equity and requires that all non owner changes in equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. ASU 2011-05 requires

13

Pacific Office Properties Trust, Inc.
Notes to Consolidated Financial Statements



retrospective application and will be effective for interim and annual reporting periods beginning after December 15, 2011. The adoption of ASU 2011-05 did not have an impact on our disclosures of comprehensive income, because we do not have other comprehensive income.

In September 2011, the FASB issued ASU No. 2011-08, Intangibles - Goodwill and Other (Topic 350): Testing Goodwill for Impairment (“ASU 2011-08”), which is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. Under the amendments in ASU No. 2011-08, an entity, through an assessment of qualitative factors, is not required to calculate the estimated fair value of a reporting unit, in connection with the two-step goodwill impairment test, unless the entity determines that it is more likely than not that its fair value is less than its carrying amount. ASU No. 2011-08 applies to our disclosures in Note 2 related to our annual goodwill impairment test. Our adoption of this guidance did not materially affect our consolidated financial statements or disclosures.

3. Investments in Real Estate, net

Our investments in real estate, net, at June 30, 2012 (unaudited), and at December 31, 2011, are summarized as follows (in thousands):
 
 
June 30,
2012
 
December 31,
2011
Land and land improvements
$
40,178

 
$
48,942

Building and building improvements
200,985

 
249,095

Tenant improvements
27,768

 
29,629

Construction in progress
849

 
936

Furniture, fixtures and equipment
1,257

 
1,354

Investments in real estate
271,037

 
329,956

Less:  accumulated depreciation
(45,438
)
 
(48,254
)
Investments in real estate, net
$
225,599

 
$
281,702


4. Intangible Assets and Acquired Above- and Below-Market Leases

Our identifiable intangible assets and acquired above- and below-market leases, net, at June 30, 2012 (unaudited), and at December 31, 2011, are summarized as follows (in thousands):
 

14

Pacific Office Properties Trust, Inc.
Notes to Consolidated Financial Statements



 
June 30,
2012
 
December 31,
2011
Acquired leasing commissions:
 
 
 
Gross amount
$
6,157

 
$
7,283

Accumulated amortization
(3,756
)
 
(4,290
)
Net balance
2,401

 
2,993

 
 
 
 
Acquired leases in place:
 

 
 

Gross amount
6,507

 
10,188

Accumulated amortization
(6,126
)
 
(8,471
)
Net balance
381

 
1,717

 
 
 
 
Acquired tenant relationship costs:
 

 
 

Gross amount
9,880

 
12,844

Accumulated amortization
(5,901
)
 
(6,264
)
Net balance
3,979

 
6,580

 
 
 
 
Acquired other intangibles:
 

 
 

Gross amount
3,054

 
3,126

Accumulated amortization
(1,033
)
 
(1,056
)
Net balance
2,021

 
2,070

 
 
 
 
Intangible assets, net
$
8,782

 
$
13,360

 
 
 
 
Acquired above-market leases:
 

 
 

Gross amount
$
1,394

 
$
2,011

Accumulated amortization
(1,313
)
 
(1,819
)
Acquired above-market leases, net
$
81

 
$
192

 
 
 
 
Acquired below-market leases:
 

 
 

Gross amount
$
6,975

 
$
9,084

Accumulated amortization
(2,816
)
 
(3,878
)
Acquired below-market leases, net
$
4,159

 
$
5,206


5. Investments in Unconsolidated Joint Ventures

At June 30, 2012, we owned interests in 9 joint ventures (of which we have managing ownership interests in 6), holding 15 office properties, comprised of 32 office buildings and approximately 2.5 million rentable square feet.  One of our joint ventures also owns a sports club associated with our City Square property in Phoenix, Arizona. Our ownership interest percentages in these joint ventures range from 5.0% to 32.2%.  For some of these joint ventures, in exchange for our managing ownership interest and related equity investment, we are entitled to fees, preferential allocations of earnings and cash flows. Following our April 1, 2012 externalization of management, certain of these amounts will be payable to Parallel Capital Partners for property management and other services.
 
At June 30, 2012 and December 31, 2011, the JV Basis Differential was approximately $(0.1) million and is included in “Investments in unconsolidated joint ventures” in the accompanying consolidated balance sheet. During the six months ended June 30, 2012, we recognized an insignificant amount of amortization expense attributable to the JV Basis Differential, which is included in “Equity in net earnings of unconsolidated joint ventures” in the accompanying consolidated statement of operations.

We account for our investments in joint ventures under the equity method of accounting.

The following tables summarize financial information for our unconsolidated joint ventures (in thousands):

15

Pacific Office Properties Trust, Inc.
Notes to Consolidated Financial Statements



 
 
Three Months Ended
 
Six Months Ended
 
 
June 30,
 
June 30,
 
 
2012
 
2011
 
2012
 
2011
Revenues:
 
 
 
 
 
 
 
 
Rental
 
$
10,138

 
$
12,694

 
$
21,025

 
$
23,254

Other
 
2,690

 
3,161

 
5,683

 
5,782

Total revenues
 
12,828

 
15,855

 
26,708

 
29,036

Expenses:
 
 

 
 

 
 

 
 

Rental operating
 
6,578

 
7,526

 
13,366

 
12,855

Depreciation and amortization
 
4,541

 
6,165

 
9,306

 
11,873

Interest
 
7,373

 
7,263

 
21,603

 
11,738

Loss on extinguishment of debt
 
2,342

 

 
2,342

 

Acquisition costs
 

 
1,039

 

 
1,039

Total expenses
 
20,834

 
21,993

 
46,617

 
37,505

Net loss
 
$
(8,006
)
 
$
(6,138
)
 
$
(19,909
)
 
$
(8,469
)
 
 
 

 
 

 
 

 
 

Equity in net earnings (loss) of unconsolidated joint ventures(a)
 
$
22

 
$
(1,490
)
 
$
527

 
$
(1,394
)
 
 
June 30,
2012
 
December 31,
2011
Investment in real estate, net
$
280,769

 
$
344,425

Other assets
65,827

 
70,069

Total assets
346,596

 
414,494

Mortgage and other loans
298,807

 
332,786

Other liabilities
29,193

 
19,909

Total liabilities
$
328,000

 
$
352,695

 
 
 
 
Investment in unconsolidated joint ventures
$
4,791

 
$
4,980


(a)
The total earnings of all the respective joint ventures of the Company, except for one joint venture that owns the Bank of Hawaii Waikiki Center property, for the periods presented, are in a loss position. However, the equity in net earnings of the joint ventures attributable to the Company is positive for the three and six month periods ended June 30, 2012. This occurred because the Company’s effective ownership in the various joint ventures ranges from 5.0% to approximately 32.2% and therefore only a portion of the losses of the joint ventures was attributable to the Company. In addition, the Company earns a priority return which, for the three and six month periods ended June 30, 2012, exceeded the attributable losses, resulting in net earnings attributable to the Company for the periods.
  
6. Other Assets, net

 Other assets, net, at June 30, 2012 (unaudited), and December 31, 2011, consist of the following (in thousands):
 
 
June 30,
2012
 
December 31,
2011
Deferred loan fees, net of accumulated amortization of $1.1 million and $1.6 million at June 30, 2012 and December 31, 2011, respectively
$
934

 
$
1,245

Prepaid expenses
205

 
1,180

Total other assets, net
$
1,139

 
$
2,425


7. Accounts Payable and Other Liabilities

Accounts payable and other liabilities at June 30, 2012 (unaudited), and at December 31, 2011, consist of the following (in thousands):

16

Pacific Office Properties Trust, Inc.
Notes to Consolidated Financial Statements



 
 
June 30,
2012
 
December 31,
2011
Accounts payable
$
506

 
$
218

Interest payable
8,104

 
7,726

Deferred revenue
1,226

 
1,126

Security deposits
1,812

 
1,901

Deferred straight-line ground rent
11,527

 
10,804

Accrued expenses
7,952

 
8,210

Asset retirement obligations
611

 
613

Total accounts payable and other liabilities
$
31,738

 
$
30,598


8. Mortgage and Other Loans

A summary of our mortgage and other loans, net of discount or premium, at June 30, 2012 (unaudited) and December 31, 2011 is as follows (in thousands):
 
 
 
Outstanding Principal Balance, Net at
 
 
 
 
Property
 
June 30,
2012
 
December 31,
2011
 
Interest Rate
 
Maturity Date
Clifford Center
 
$
2,717

 
$
2,907

 
4.375
%
 
8/15/2014
Clifford Center Land
 
4,833

 

 
4.00
%
 
2/17/2017
Sorrento Technology Center(a)
 

 
11,452

 
 
 
 
First Insurance Center(c)
 

 
37,626

 
 
 
 
First Insurance Center(c)
 

 
13,860

 
 
 
 
Pan Am Building
 
59,977

 
59,974

 
6.17
%
 
8/11/2016
Waterfront Plaza
 
100,000

 
100,000

 
6.37
%
 
9/11/2016
Waterfront Plaza
 
11,000

 
11,000

 
6.37
%
 
9/11/2016
Davies Pacific Center
 
94,411

 
94,344

 
5.86
%
 
11/11/2016
Subtotal
 
272,938

 
331,163

 
 

 
 
Revolving line of credit (b)
 
25,000

 
25,000

 
1.25
%
 
12/31/2013
Total
 
$
297,938

 
$
356,163

 
 

 
 
 
(a)
We ceased making the required debt service payments on this loan in the second quarter of 2011, and on June 6, 2011, we received a notice of default accelerating the maturity date of the loan. On January 5, 2012, the lender foreclosed on the loan and took back the property.
(b)
The revolving line of credit matures on December 31, 2013.  Amounts borrowed under the revolving line of credit bear interest at a fluctuating annual rate equal to the effective rate of interest paid by the Lender on time certificates of deposit, plus 1.00%.  See “Revolving Line of Credit” below.
(c)
In June 2012, the First Insurance Center property was sold and the loans were assumed by the purchaser of the property as part of the sale transaction.

The lenders’ collateral for notes payable, with the exception of the Clifford Center note payable, is the property and, in some instances, cash reserve accounts, ownership interests in the underlying entity owning the real property, leasehold interests in certain ground leases, rights under certain service agreements, and letters of credit posted by certain related parties of the Company.  The lenders’ collateral for the Clifford Center note payable is the leasehold property as well as guarantees from affiliates of the Company.  The Operating Partnership has agreed to indemnify these affiliates (Messrs. Shidler and Reynolds) to the extent of their guaranty liability.  In management’s judgment, it would be a remote possibility for us to incur any material liability under these indemnities that would have a material adverse effect on our financial condition, results of operations or cash flows.

The existing and scheduled maturities for our mortgages and other loans for the periods succeeding June 30, 2012 are as follows (in thousands and includes scheduled principal paydowns):


17

Pacific Office Properties Trust, Inc.
Notes to Consolidated Financial Statements



2012
$
248

2013
25,499

2014
2,273

2015
130

2016
266,135

Thereafter
4,265

Total mortgage and other loans(1)
$
298,550

 
(1)
This balance is the gross amount and does not include the discount of $612 thousand which is included in the outstanding balance of $297,938 thousand as shown in “Mortgage and other loans, net,” in the accompanying consolidated balance sheet.

Revolving Line of Credit

On September 2, 2009, we entered into a Credit Agreement (the “FHB Credit Facility”) with First Hawaiian Bank (the “Lender”).  The FHB Credit Facility initially provided us with a revolving line of credit in the principal sum of $10 million.  On December 31, 2009, we amended the FHB Credit Facility to increase the maximum principal amount available for borrowing under the revolving line of credit to $15 million.  On May 25, 2010, we entered into an amendment with the Lender to increase the maximum principal amount available for borrowing thereunder from $15 million to $25 million and to extend the maturity date from September 2, 2011 to December 31, 2013.  Amounts borrowed under the FHB Credit Facility bear interest at a fluctuating annual rate equal to the effective rate of interest paid by the Lender on time certificates of deposit, plus 1.00%.  We are permitted to use the proceeds of the line of credit for working capital and general corporate purposes, consistent with our real estate operations and for such other purposes as the Lender may approve.  As of both June 30, 2012 and December 31, 2011, we had outstanding borrowings of $25.0 million under the FHB Credit Facility. During each of the three month periods ended June 30, 2012 and 2011, we recognized $0.1 million in interest to the Lender. During each of the six month periods ended June 30, 2012 and 2011, we recognized $0.2 million in interest to the Lender.

As security for the FHB Credit Facility, as amended, Shidler Equities, L.P., a Hawaii limited partnership controlled by Mr. Shidler (“Shidler LP”), has pledged to the Lender a certificate of deposit in the principal amount of $25.0 million.  As a condition to this pledge, the Operating Partnership and Shidler LP entered into an indemnification agreement pursuant to which the Operating Partnership agreed to indemnify Shidler LP from any losses, damages, costs and expenses incurred by Shidler LP in connection with the pledge.  In addition, to the extent that all or any portion of the certificate of deposit is withdrawn by the Lender and applied to the payment of principal, interest and/or charges under the FHB Credit Facility, the Operating Partnership agreed to pay to Shidler LP interest on the withdrawn amount at a rate of 7.0% per annum from the date of the withdrawal until the date of repayment in full by the Operating Partnership to Shidler LP.  Pursuant to this indemnification agreement, as amended, the Operating Partnership also agreed to pay to Shidler LP an annual fee of 2.0% of the entire $25.0 million principal amount of the certificate of deposit. During each of the three month periods ended June 30, 2012 and 2011, we recognized $0.1 million in interest to Shidler LP for the annual fee. During each of the six month periods ended June 30, 2012 and 2011, we recognized $0.2 million in interest to Shidler LP for the annual fee.

The FHB Credit Facility contains various customary covenants, including covenants relating to disclosure of financial and other information to the Lender, maintenance and performance of our material contracts, our maintenance of adequate insurance, payment of the Lender’s fees and expenses, and other customary terms and conditions.

9. Unsecured Notes Payable to Related Parties

At June 30, 2012 and December 31, 2011, we had promissory notes payable by the Operating Partnership to certain affiliates in the aggregate principal amount of $21.1 million, at both dates, which were originally issued as consideration to the affiliates, for having funded certain capital improvements prior to the completion of our formation transactions and upon the exercise of options granted to us by POP Venture, LLC (“Venture”) and its affiliates as part of our formation transactions in 2008. The promissory notes accrue interest at a rate of 7%, per annum, with interest payable quarterly, subject to the Operating Partnership’s right to defer the payment of interest for any or all periods up until the date of maturity. The promissory notes mature on various dates commencing on March 19, 2013 through August 31, 2013, but the Operating Partnership may elect to extend maturity for one additional year. Maturity accelerates upon the occurrence of a) an underwritten public offering of at least $75 million of our common stock; b) the sale of substantially all the assets of the Company; or c) the merger of the Company with another entity. The promissory notes are unsecured obligations of the Operating Partnership.


18

Pacific Office Properties Trust, Inc.
Notes to Consolidated Financial Statements



For the period from March 20, 2008 through June 30, 2012, interest payments on the unsecured notes payable to related parties have been deferred with the exception of $0.3 million which was related to the notes exchanged for shares of common stock in 2009.  At June 30, 2012 and December 31, 2011, $7.1 million and $6.1 million, respectively, of accrued interest attributable to unsecured notes payable to related parties is included in “Accounts payable and other liabilities” in the accompanying consolidated balance sheets.

10. Commitments and Contingencies

Minimum Future Ground Rents

We hold a long-term ground leasehold interest in our Waterfront Plaza property. The Waterfront Plaza ground lease expires December 31, 2060.  The annual rental obligation has fixed increases at 5-year intervals until it resets on January 1, 2036, 2041, 2046, 2051, and 2056 to an amount equal to the greater of (i) 8.0% of the fair market value of the land and (ii) the ground rent payable for the prior period.

Prior to February 23, 2012, we also held a long-term ground leasehold interest in our Clifford Center property. However, on February 23, 2012, we completed the acquisition of the fee interest in the land underlying the property for aggregate consideration of $6.5 million, through a new wholly-owned subsidiary. As a result, the financial statement impact related to the ground lease obligation is eliminated in consolidation.

Contingencies

From time to time, we may be subject to various legal proceedings and claims that arise in the ordinary course of business.  These matters are generally covered by insurance, subject to deductibles and other customary limitations on recoveries.  We believe that the ultimate settlement of these actions will not have a material adverse effect on our consolidated financial position and results of operations or cash flows.

Concentration of Credit Risk

Our operating properties are located in Honolulu, San Diego, Los Angeles, Orange County and Phoenix. The ability of the tenants to honor the terms of their respective leases is dependent upon the economic, regulatory and social factors affecting the markets in which the tenants operate. As of June 30, 2012, no single tenant accounts for 10% or more of our total annualized base rents.  We perform ongoing credit evaluations of our tenants for potential credit losses.

Financial instruments that subject us to credit risk consist primarily of cash, accounts receivable, deferred rents receivable and an interest rate contract. We maintain our cash and cash equivalents and restricted cash on deposit with what management believes are relatively stable financial institutions. Accounts at each institution are insured by the Federal Deposit Insurance Corporation up to the maximum amount; and, to date, we have not experienced any losses on our invested cash. Restricted cash held by lenders is held by those lenders in accounts maintained at major financial institutions.

Conditional Asset Retirement Obligations

We record a liability for a conditional asset retirement obligation, defined as a legal obligation to perform an asset retirement activity in which the timing and/or method of settlement is conditional on a future event that may or may not be within a company’s control, when the fair value of the obligation can be reasonably estimated.  Depending on the age of the construction, certain properties in our portfolio may contain non-friable asbestos.  If these properties undergo major renovations or are demolished, certain environmental regulations are in place, which specify the manner in which the asbestos, if present, must be handled and disposed. Based on our evaluation of the physical condition and attributes of certain of our properties, we recorded conditional asset retirement obligations related to asbestos removal.  As of June 30, 2012 and December 31, 2011, the liability in our consolidated balance sheets for conditional asset retirement obligations was $0.6 million for both periods.  The accretion expense for the three and six months ended June 30, 2012 and 2011 was not significant.

Waterfront Plaza Ground Lease

We are subject to a surrender clause under the Waterfront Plaza ground lease that provides the lessor with the right to require us, at our own expense, to raze and remove all improvements from the leased land, contingent on the lessor’s decision at the time the ground lease expires on December 31, 2060.  Accordingly, as of June 30, 2012 and December 31, 2011, the liability in our consolidated balance sheets for this asset retirement obligation was $0.3 million for both periods. The accretion expense was not significant for the three and six months ended June 30, 2012 and 2011, respectively.

19

Pacific Office Properties Trust, Inc.
Notes to Consolidated Financial Statements




Environmental Matters

We follow the policy of monitoring our properties for the presence of hazardous or toxic substances.  While there can be no assurance that a material environmental liability does not exist, we are not currently aware of any environmental liability with respect to the properties that would have a material effect on our financial condition, results of operations, and cash flow.  Further, we are not aware of any environmental liability or any unasserted claim or assessment with respect to an environmental liability other than our conditional asset retirement obligations that we believe would require additional disclosure or the recording of a loss contingency.

Capital Commitments

We are required by certain leases and loan agreements to complete tenant and building improvements. As of June 30, 2012, this amount is projected to be $2.6 million during the remainder of 2012.  We anticipate that our reserves, as well as other sources of liquidity, including existing cash on hand, our cash flows from operations, financing and investing activities will be sufficient to fund our committed capital expenditures.

Tax Protection Arrangements

A sale of any of the Contributed Properties that would not provide continued tax deferral to POP Venture, LLC (“Venture”) is contractually restricted until March 2018, which is 10 years after the closing of the transaction related to such properties.  In addition, we have agreed that, during such 10-year period, we will not prepay or defease any mortgage indebtedness of such properties, other than in connection with a concurrent refinancing with non-recourse mortgage debt of an equal or greater amount and subject to certain other restrictions.  Furthermore, if any such sale or defeasance is foreseeable, we are required to notify Venture and to cooperate with it in considering strategies to defer or mitigate the recognition of gain under the Code by any of the equity interest holders of the recipient of the Operating Partnership units.

In May of 2011, we defaulted on our loan secured by the Sorrento Technology Center property. We ceased making the required debt service payments on the loan and on June 6, 2011, we received a notice of default. On January 5, 2012, the lender foreclosed on the loan and took back the property. As a result, certain contract parties may claim they are entitled to a make-whole cash payment under the tax protection agreements relating to the property.  We do not believe that this foreclosure requires indemnity under the tax protection agreements. However, if the contract parties contest this interpretation and are successful, we believe that liability would not exceed $3.0 million, which is the estimated approximate built-in gain associated with the property multiplied by the highest applicable tax rate, plus a gross-up amount. 

As previously disclosed, on February 15, 2012, we entered into two Purchase and Sale Agreements to sell our fee and leasehold interests in our First Insurance Center property, located in Honolulu, Hawaii, to an unaffiliated third party for aggregate consideration of approximately $70.5 million (including the assumption of $52 million in existing debt encumbering the property). The sale transactions pursuant to the Purchase and Sale Agreements were completed in June 2012. As a result of the sale, certain contract parties may claim they are entitled to a make-whole cash payment under the tax protection agreements relating to the property.  We do not believe that any potential liability under these agreements could exceed $9.1 million, which is the estimated approximate built-in gain associated with the property multiplied by the highest applicable tax rate, plus a gross-up amount.  However, any requested payment could be challenged by us or significantly reduced. We believe that liability under these tax protection agreements is neither probable nor reasonably estimable at this time and accordingly, have not accrued any amounts for any such liability.

Indemnities

The mortgage debt that we maintain for our consolidated properties and unconsolidated joint venture properties is typically property-specific debt that is non-recourse to our Operating Partnership, except for customary recourse carve-outs for borrower misconduct and environmental liabilities. The recourse liability for borrower misconduct and environmental liabilities was guaranteed by James C. Reynolds. Our Operating Partnership has agreed to indemnify Mr. Reynolds to the extent of his guaranty liability. This debt strategy isolates mortgage liabilities in separate, stand-alone entities, allowing us to have only our property-specific equity investment at risk, except to the extent of the recourse carve-outs. In management’s judgment, it would be unlikely for us to incur any material liability under these indemnities that would have a material adverse effect on our financial condition, results of operations or cash flows.

20

Pacific Office Properties Trust, Inc.
Notes to Consolidated Financial Statements





11. Equity (Deficit) and Earnings (Loss) per Share

Total Equity (Deficit)

The changes in total equity (deficit) for the period from December 31, 2011 to June 30, 2012 are shown below (in thousands):
 
Pacific Office Properties Trust, Inc.
 
Non-controlling interest - Preferred
 
Non-controlling interest - Common
 
Total
Balance at December 31, 2011
$
(134,406
)
 
$
127,268

 
$
(31,321
)
 
$
(38,459
)
Net income (loss)
437

 
1,136

 
(1,566
)
 
7

Dividends and distributions
(875
)
 
(1,136
)
 

 
(2,011
)
Balance at June 30, 2012
$
(134,844
)
 
$
127,268

 
$
(32,887
)
 
$
(40,463
)

Stockholders’ Equity (Deficit)

Our Class A Common Stock (which was listed on the NYSE Amex until April 5, 2012 and is now quoted in the OTCQB tier of the OTC Marketplace) and our Class B Common Stock are identical in all respects, except that in the event of liquidation the Class B Common Stock will not be entitled to any portion of our net assets, which will be allocated and distributed to the holders of the Class A Common Stock. Shares of our Class A Common Stock and Class B Common Stock vote together as a single class and each share is entitled to one vote on each matter to be voted upon by our stockholders.  Dividends on the Class A Common Stock and Class B Common Stock are payable at the discretion of our Board of Directors.

Our Senior Common Stock ranks senior to our Class A Common Stock and Class B Common Stock with respect to dividends and distribution of amounts upon liquidation.  It has a $10.00 per share (plus accrued and unpaid dividends) liquidation preference.  Subject to the preferential rights of any future series of preferred shares, holders of Senior Common Stock are entitled to receive, when and as declared by the Company’s Board of Directors, cumulative cash dividends in an amount per share equal to a minimum of $0.725 per share per annum, payable monthly.  Should the dividend payable on the Class A Common Stock exceed the rate of $0.20 per share per annum, the Senior Common Stock dividend would increase by 25% of the amount by which the Class A Common Stock dividend exceeds $0.20 per share per annum.  Holders of Senior Common Stock have the right to vote on all matters presented to stockholders as a single class with holders of the Class A Common Stock, the Class B Common Stock and the Company’s outstanding share of Proportionate Voting Preferred Stock (as discussed below).  Each share of the Company’s Class A Common Stock, the Class B Common Stock and the Senior Common Stock is entitled to one vote on each matter to be voted upon by the Company’s stockholders.  Shares of Senior Common Stock may be exchanged, at the option of the holder, for shares of Class A Common Stock after the fifth anniversary of the issuance of such shares of Senior Common Stock.  The exchange ratio is to be calculated using a value for our Class A Common Stock based on the average of the trailing 30-day closing price of the Class A Common Stock on the date the shares are submitted for exchange, but in no event less than $1.00 per share, and a value for the Senior Common Stock of $10.00 per share.  As of June 30, 2012 and December 31, 2011, we had a total of 2,410,839 shares of Senior Common Stock issued and outstanding.  We terminated our continuous public offering of Senior Common Stock in February 2011 and do not expect to issue any additional shares of Senior Common Stock.

General Partnership Interest
 
The Company’s general partnership interest in the Operating Partnership is denominated in a number of Common Units equal to the number of shares of our Class A Common Stock and Class B Common Stock outstanding.  Our general partnership interest includes the right to participate in distributions of the Operating Partnership to holders of Common Units in a percentage equal to the quotient obtained by dividing (a) the number of shares of our Class A Common Stock and Class B Common Stock outstanding by (b) the sum of shares of our Class A Common Stock and Class B Common Stock outstanding plus the number of shares of our Class A Common Stock for which the outstanding Common Units of the Operating Partnership may be redeemed.  We also hold a number of Senior Common Units corresponding to the number of shares of Senior Common Stock outstanding, which entitle us to receive distributions from the Operating Partnership in an amount per Senior Common Unit equal to the per share dividend payable to holders of our Senior Common Stock.
 
Non-controlling Interests

Non-controlling interests include the interests in the Operating Partnership that are not owned by the Company, which amounted

21

Pacific Office Properties Trust, Inc.
Notes to Consolidated Financial Statements



to all of the Preferred Units and 78.16% of the Common Units outstanding as of June 30, 2012.  During the three and six months ended June 30, 2012 and 2011, no Common Units or Preferred Units were redeemed or issued. As of June 30, 2012, 46,698,532 shares of our Class A Common Stock were reserved for issuance upon redemption of outstanding Common Units and Preferred Units.
 
Upon initial issuance in March 2008, each Preferred Unit was convertible into 7.1717 Common Units, but no earlier than the later of (i) March 19, 2010, and (ii) the date we consummate an underwritten public offering (of at least $75 million) of our common stock. Upon conversion of the Preferred Units to Common Units, the Common Units were redeemable by the holders on a one-for-one basis for shares of our Class A Common Stock or cash, as elected by the Company, but no earlier than one year after the date of their conversion from Preferred Units to Common Units. The Preferred Units have fixed rights to annual distributions at an annual rate of 2% of their liquidation preference of $25 per Preferred Unit and priority over Common Units in the event of a liquidation of the Operating Partnership. At June 30, 2012, the cumulative unpaid distributions attributable to Preferred Units were $3.4 million.  We anticipate continuing to accrue these distributions during the remainder of 2012.

On December 30, 2009, we amended certain provisions of the partnership agreement of the Operating Partnership (the “Partnership Agreement”) relating to the redemption rights of the Common Units and Preferred Units.  The Common Units issued upon the completion of our formation transactions on March 19, 2008 were reclassified as Class B Common Units, which are redeemable by the holder on a one-for-one basis for shares of Class A Common Stock or a new class of Common Units, designated Class C Common Units, which have no redemption rights, as elected by a majority of our independent directors.  All other outstanding Common Units were reclassified as Class A Common Units, which are redeemable by the holders on a one-for-one basis for shares of Class A Common Stock or cash, as elected by a majority of our independent directors.  If converted, the Preferred Units will convert into Class B Common Units.  Furthermore, the Preferred Unit put option was modified by eliminating the various alternative currencies possible upon exercise of the put and permitting only the issuance of new preferred units in settlement of an exercised put.  The modification of the terms of the Preferred Units was more than inconsequential and therefore triggered a revaluation of the Preferred Units to their fair value on the modification date.  As a result of the amendments to the Partnership Agreement, the Non-Controlling Interests attributable to the Common Units and Preferred Units were reclassified from mezzanine equity to permanent equity on the consolidated balance sheet.  Simultaneously, the excess of market value over carrying value for the Preferred Units was booked as a fair value adjustment of Preferred Units on the consolidated statement of operations.

Common Units of all classes and Preferred Units of the Operating Partnership do not have any right to vote on any matters presented to our stockholders. As part of our formation transactions, we issued to Pacific Office Management one share of Proportionate Voting Preferred Stock.  The Proportionate Voting Preferred Stock has no dividend rights and minimal rights to distributions in the event of liquidation, but it entitles its holder to vote on all matters for which the holders of Class A Common Stock are entitled to vote.  The Proportionate Voting Preferred Stock entitles its holder to cast a number of votes equal to the total number of shares of Class A Common Stock issuable upon redemption for shares of the Common Units and Preferred Units issued in connection with the completion of our formation transactions on March 19, 2008.  This number will decrease to the extent that these Operating Partnership units are redeemed for shares of Class A Common Stock in the future. The number will not increase in the event of future unit issuances by the Operating Partnership.  As of June 30, 2012, that share of Proportionate Voting Preferred Stock represented 88% of our voting power.  In connection with the internalization of our management in February 2011, Pacific Office Management sold the share of Proportionate Voting Preferred Stock to Pacific Office Holding, Inc., a corporation owned by Mr. Shidler and certain of our current and former executive officers and other affiliates, for nominal consideration.  Pacific Office Holding, Inc. has agreed to cast its Proportionate Voting Preferred Stock votes on any matter in direct proportion to votes that are cast by limited partners of our Operating Partnership holding the Common Units and Preferred Units issued in the formation transactions.

As of June 30, 2012, Venture owned 46,173,693 shares of our Class A Common Stock assuming that all Operating Partnership units were fully redeemed for shares on such date, notwithstanding the restrictions on redemption noted above.  Assuming the immediate redemption of all the Operating Partnership units held by Venture, Venture and its related parties control approximately 91.5% of the total voting power in the Company.

Income (Loss) per Share
 
We present both basic and diluted earnings per share (“EPS”). Basic EPS is computed by dividing net loss attributable to common stockholders by the weighted average number of shares of Class A Common Stock and Class B Common Stock outstanding during each period. Diluted EPS is computed by dividing net loss attributable to common stockholders for the period by the number of shares of Class A Common Stock and Class B Common Stock that would have been outstanding assuming the issuance of shares of Class A Common Stock for all potentially dilutive shares of Class A Common Stock outstanding during each period.

22

Pacific Office Properties Trust, Inc.
Notes to Consolidated Financial Statements



Net income or loss in the Operating Partnership is allocated in accordance with the Partnership Agreement among our general partner and limited partner Common Unit holders in accordance with their weighted average ownership percentages in the Operating Partnership of 21.84% and 78.16%, respectively, as of June 30, 2012, after taking into consideration the priority distributions allocated to the limited partner preferred unit holders in the Operating Partnership. The following is the basic and diluted loss per share (in thousands, except share and per share amounts):
 
For the three months ended June 30,
 
For the six months ended June 30,
 
2012
 
2011
 
2012
 
2011
Net income (loss) attributable to common stockholders - basic and diluted(1)
$
139

 
$
(2,719
)
 
$
(438
)
 
$
(4,111
)
 
 
 
 
 
 
 
 
Weighted average number of common shares
3,941,242

 
3,909,429

 
3,941,242

 
3,906,307

Potentially dilutive common shares(2)

 

 

 

Weighted average number of common shares outstanding - basic and diluted
3,941,242

 
3,909,429

 
3,941,242

 
3,906,307

Net income (loss) per common share - basic and diluted
$
0.04

 
$
(0.70
)
 
$
(0.11
)
 
$
(1.05
)

(1)
For the three and six months ended June 30, 2012 and 2011, net income (loss) attributable to common stockholders includes $0.6 million and $1.1 million of priority allocation to Preferred Unit holders each, respectively, which is included in non-controlling interests in the consolidated statements of operations. The Company continues to accrue the distributions but does not anticipate paying the distributions in the near term. See below for additional detail.
(2)
For the three and six months ended June 30, 2012, 14,101,004 shares of Class A Common Stock which may be issued upon redemption of Common Units, 32,597,528 shares of Class A Common Stock which may be issued upon redemption of Preferred Units, and 2,410,839 shares of Senior Common Stock were excluded from the calculation of diluted earnings per share because they were anti-dilutive due to our net loss from continuing operations position;
For the three and six months ended June 30, 2011, 14,101,004 shares of Class A Common Stock which may be issued upon redemption of Common Units, 32,597,528 shares of Class A Common Stock which may be issued upon redemption of Preferred Units, and 2,414,085 shares of Senior Common Stock were excluded from the calculation of diluted earnings per share because they were anti-dilutive due to our net loss from continuing operations position;
Refer to “Non-Controlling Interests” and “Stockholders’ Equity (Deficit)” in this footnote for the redemption and conversion terms and conditions of the Preferred Units and Senior Common Stock.

Dividends and Distributions

For the fourth quarter of 2010, our board of directors authorized a cash distribution of $0.011 per Common Unit and a cash dividend of $0.011 per share of our Class A Common Stock and Class B Common Stock, which was paid on January 17, 2011 to holders of record as of December 31, 2010.  In addition, we paid 2% distributions, or $1.25 per unit, to the holder of the Preferred Units for the quarter ended December 31, 2010 on January 17, 2011.  We relied upon borrowings under our revolving line of credit to pay a portion of these dividends and distributions.

Our board of directors has authorized daily dividends on the Senior Common Stock, payable to holders of record of the Senior Common Stock as of the close of business on each day of the period commencing April 22, 2010 through September 30, 2012, in an amount equal to an annualized rate of 7.25%. Dividends declared for each month have been or will be paid on or about the 15th day of the following month.

Amounts accumulated for distribution to stockholders and Operating Partnership unit holders are invested primarily in interest-bearing accounts which are consistent with our intention to maintain our qualification as a REIT. At June 30, 2012, the cumulative unpaid distributions attributable to Preferred Units were $3.4 million, which we do not anticipate to pay in 2012.

Dividends declared on the Class A Common Stock, Class B Common Stock and Senior Common Stock are included in “Cumulative deficit” in the accompanying consolidated balance sheets. Distributions on Common Units and Preferred Units are included in “Non-controlling interests” in the accompanying consolidated balance sheets.


23

Pacific Office Properties Trust, Inc.
Notes to Consolidated Financial Statements



12. Acquisition and Disposition Activity

Acquisition of Clifford Center Land

On February 23, 2012, we completed the acquisition of the fee interest in the land underlying our Clifford Center property, located in Honolulu, Hawaii for aggregate consideration of $6.5 million. As part of the acquisition we entered into a new loan agreement with Central Pacific Bank in the amount of $4.9 million. The loan bears interest at 4.00% per annum, requires monthly principal and interest payments of $25.7 thousand and includes a balloon payment of $4.3 million at maturity on February 17, 2017.

Discontinued Operations

Foreclosure of Sorrento Technology Center. On January 5, 2012, the lender on the Sorrento Technology Center property, located in San Diego, California, foreclosed on the loan and took back the property. During the second quarter of 2011, an impairment charge was taken for this property to write the asset down to its fair market value, which was less than the debt. The gain recognized on foreclosure during the six months ended June 30, 2012 is a result of the write off of this property in its entirety.

Sale of First Insurance Center. On June 18, 2012, we completed the sale of the fee and leasehold interests in the First Insurance Center property, located in Honolulu, Hawaii, for aggregate consideration of approximately $70.5 million (including the assumption of $52 million of debt encumbering the property). As a result of the sale, we recorded net sales proceeds of approximately $17.3 million and recognized a gain of $5.4 million during the three and six months ended June 30, 2012, and is included in “Gain on sale of property” in the accompanying consolidated statements of operations. The operating results of the First Insurance Center property for the periods ended June 30, 2012 and 2011 are included in “Discontinued operations” in the accompanying consolidated statements of operations.

The following table summarizes the components that comprise income (loss) from discontinued operations for the three and six months ended June 30, 2012 and 2011 (in thousands):
 
For the three months ended June 30,
 
For the six months ended June 30,
 
2012
 
2011
 
2012
 
2011
Revenue
$
2,345

 
$
2,514

 
$
4,713

 
$
5,049

Expenses
(1,803
)
 
(6,091
)
 
(4,013
)
 
(8,691
)
Income (loss) from discontinued operations before gain on extinguishment of debt and gain on sale of property
542

 
(3,577
)
 
700

 
(3,642
)
Gain on extinguishment of debt

 

 
2,251

 

Gain on sale of property
5,365

 

 
5,365

 

Total income (loss) from discontinued operations
$
5,907

 
$
(3,577
)
 
$
8,316

 
$
(3,642
)

Internalization of Pacific Office Management

Until February 1, 2011, we were externally advised by Pacific Office Management, an entity that was owned and controlled by Mr. Shidler, Mr. Reynolds and certain of our current and former executive officers. Pursuant to our Advisory Agreement with Pacific Office Management, Pacific Office Management was entitled to an annual corporate management fee of one tenth of one percent (0.1)% of the gross cost basis of our total property portfolio (less accumulated depreciation and amortization), but in no event less than $1.5 million per annum.  Although we were responsible for all direct expenses incurred by us for certain services for which we were the primary service obligee, Pacific Office Management bore the cost and was not reimbursed by us for any expenses incurred by it in the course of performing operational advisory services for us, which expenses included, but were not limited to, salaries and wages, office rent, equipment costs, travel costs, insurance costs, telecommunications and supplies.  The corporate management fee was subject to reduction of up to $750,000 based upon the amounts of the direct costs that we bore. Additionally, Pacific Office Management and its affiliates were entitled to receive property management fees of 2.5% to 4.5% of the rental cash receipts collected by the properties, leasing fees consistent with the prevailing market as well as property transaction fees in an amount equal to 1% of the contract price of any acquired or disposed property; however, such property management fees, leasing fees, and property transaction fees were required to be consistent with prevailing market rates for similar services provided on an arms-length basis in the area in which the subject property is located.


24

Pacific Office Properties Trust, Inc.
Notes to Consolidated Financial Statements



Pacific Office Management was also entitled to certain fees related to any placement of debt or equity that we undertook, including (i) 0.50% of the total amount of co-investment equity capital procured, (ii) 0.50% of the total gross offering proceeds including, but not limited to, the issuance or placement of equity securities and the issuance of Operating Partnership units, and (iii) 0.50% of the principal amount of any new indebtedness related to properties that we wholly own, and on properties owned in a joint venture with co-investment partners or entity-level financings, as well as on amounts available on our credit facilities and on the principal amount of indebtedness we may issue.

Effective as of February 1, 2011 we internalized our management by terminating the Advisory Agreement and acquiring all of the outstanding stock of Pacific Office Management for an aggregate purchase price of $25,000.  Pacific Office Management waived the internalization fee equal to $1.0 million, plus certain accrued and unreimbursed expenses. The purchase price of $25,000 for Pacific Office Management was less than the fair value of the assets acquired and liabilities assumed resulting in a bargain purchase which is recognized as a gain on the acquisition date.  The gain resulted in part because previously unpaid amounts due from the wholly-owned properties were eliminated upon consolidation.  The $0.5 million gain is reflected in “Non-operating income” in the accompanying consolidated statement of operations for the six months ended June 30, 2011. 

Externalization of management

Effective April 1, 2012, we became externally advised by Shidler Pacific Advisors, an entity that is owned and controlled by Mr. Shidler. Shidler Pacific Advisors acquired substantially all of the assets of Pacific Office Management for an aggregate purchase price of $25,000 and is responsible for the day to day operations and management of the Company. For its services, Shidler Pacific Advisors is entitled to a corporate management fee of $213 thousand per quarter, which is reflected in “General and administrative” expenses in the accompanying consolidated statement of operations for the three and six months ended June 30, 2012. In addition, all of our wholly-owned properties are managed by Shidler Pacific Advisors and all of our joint venture properties are managed by Parallel Capital Partners, a related party. Shidler Pacific Advisors and Parallel Capital Partners will be entitled to receive property management fees of 2.5% to 4.5% of the rental cash receipts collected by the properties, and related fees; however, such property management and related fees are required to be consistent with prevailing market rates for similar services provided on an arms-length basis in the area in which the subject property is located.

Prior to the internalization of our management in February 2011, we paid Pacific Office Management and its related parties, and subsequent to the externalization of our management in April 2012, we paid Shidler Pacific Advisors, and its related parties, for services relating to property management, leasing, property transactions and debt placement. The fees are summarized in the table below for the indicated periods (in thousands):
 
Shidler Pacific Advisors and affiliates fees for the three and six months ended June 30, 2012
 
Pacific Office Management and affiliates fees for the one month ended January 31, 2011
Property management
$
560

 
$
255

Corporate management
213

 
63

Construction management and other
32

 
3

Total
$
805

 
$
321

 

Pacific Office Management and Shidler Pacific Advisors leased space from us at certain of our wholly-owned properties for building management and corporate offices.  The rents from these leases totaled $0.2 million for the three and six months ended June 30, 2012 from Shidler Pacific Advisors, and $0.1 million for the one month ended January 31, 2011 from Pacific Office Management.
Below is the pro forma information that reflects the specified line items of our consolidated financial statements assuming that the externalization of management had been completed as of January 1, 2011 (in thousands, except per share amounts):

25

Pacific Office Properties Trust, Inc.
Notes to Consolidated Financial Statements



 
For the three months ended June 30,
 
For the six months ended June 30,
 
2012
 
2011
 
2012
 
2011
Pro forma operating revenues
$
11,363

 
$
12,470

 
$
22,840

 
$
28,343

Pro forma operating expenses
$
(15,795
)
 
$
(28,660
)
 
$
(31,503
)
 
$
(49,994
)
Pro forma net loss attributable to common stockholders
$
(8
)
 
$
(2,156
)
 
$
(265
)
 
$
(3,808
)
Pro forma loss per share
$

 
$
(0.55
)
 
$
(0.07
)
 
$
(0.97
)

13. Related Party Transactions

During each of the three month periods ended June 30, 2012 and 2011, we incurred $0.1 million in interest to Shidler LP for the annual fee related to its security pledge for the FHB Credit Facility. During each of the six month periods ended June 30, 2012 and 2011, we incurred $0.2 million in interest to Shidler LP for this annual fee. As of June 30, 2012, we have $0.1 million of accrued annual fees included in “Accounts payable and other liabilities” in the accompanying consolidated balance sheets. See Note 8 for more discussion on the FHB Credit Facility, including the security pledge made by Shidler LP.

The Operating Partnership has agreed to indemnify James C. Reynolds with respect to all of his obligations under certain guaranties provided by Mr. Reynolds to lenders of indebtedness encumbering the Contributed Properties and certain additional properties acquired after the completion of our formation transactions.  Mr. Reynolds is the beneficial owner of approximately 12% of our Class A Common Stock, and was a director and stockholder of Pacific Office Management prior to our acquisition of Pacific Office Management.  See Note 10 for additional discussion on these indemnities.

At June 30, 2012 and December 31, 2011, $7.1 million and $6.1 million of accrued interest attributable to unsecured notes payable to related parties, respectively, is included in “Accounts payable and other liabilities” in the accompanying consolidated balance sheets.  See Note 9 for a detailed discussion on these notes payable.

Prior to the internalization of our management effective as of February 1, 2011, we were externally advised by Pacific Office Management, an entity owned and controlled by Mr. Shidler, Mr. Reynolds and certain of our current and former executive officers. Effective April 1, 2012, we are externally advised by Shidler Pacific Advisors, an entity that is owned and controlled by Mr. Shidler. At June 30, 2012, we have $0.2 million owed to Shidler Pacific Advisors included in “Accounts payable and other liabilities” in the accompanying consolidated balance sheets. See Note 12 for additional discussion on our advisors and fees earned by Pacific Office Management prior to internalization, and by Shidler Pacific Advisors subsequent to externalization.

At June 30, 2012 and December 31, 2011, we have $0.04 million and $0.4 million, respectively, of amounts receivable from related parties included in “Rents and other receivables, net” in our accompanying consolidated balance sheets, which consists primarily of property management fees and lease commission fees due from our joint ventures relating to the time during which our management was internalized from February 2011 to March 2012.  See Note 12 for additional discussion of the internalization of management in February 2011 and the externalization of management in April 2012.

14. Share-Based Payments

On May 21, 2008, the Board of Directors of the Company adopted the 2008 Directors’ Stock Plan, as amended and restated (the “2008 Directors’ Plan”), subject to stockholder approval. The Company reserved 150,000 shares of the Company’s Class A Common Stock under the 2008 Directors’ Plan for the issuance of stock options, restricted stock awards, stock appreciation rights and performance awards. The 2008 Directors’ Plan was approved by our stockholders at our annual meeting of stockholders on May 12, 2009.

On June 16, 2010, the Company issued restricted stock units representing 47,615 shares under the 2008 Directors’ Plan, 38,092 of which awards vested on the first anniversary of the grant date.  The grant date fair value of each restricted stock unit was $4.20, which was the Company’s closing stock price on June 16, 2010.  On March 4, 2011, Thomas R. Hislop resigned from the Company’s Board of Directors.  Upon resignation, he forfeited 9,523 shares of unvested restricted stock units that were granted in 2010.  Accordingly, the Company reversed the stock compensation expense recognized related to these forfeited shares.

The Company had no equity awards outstanding as of June 30, 2012 and December 31, 2011. As of June 30, 2012, all of our share-based payments to directors have vested. In connection with these grants, the Company recorded $0 and $40 thousand, respectively, of stock-based compensation expense for the three months ended June 30, 2012 and 2011. The Company recorded

26

Pacific Office Properties Trust, Inc.
Notes to Consolidated Financial Statements



$0 and $60 thousand of stock-based compensation expense for the six months ended June 30, 2012 and 2011. These amounts are included in “General and administrative” expenses in the accompanying consolidated statement of operations.

15. Segment Reporting

We own and operate primarily institutional-quality office properties in Hawaii.  Prior to the foreclosure of the loan on our Sorrento Technology Center property (located in San Diego, California) and the contribution of our City Square property (located in Phoenix, Arizona) into a joint venture, we aggregated our operations by geographic region into two reportable segments (Honolulu and the Western United States mainland) based on the similar economic characteristics of the properties located in each of these regions. The products at all our properties include primarily rental of office space and other tenant services, including parking and storage space rental.  We also have certain corporate level income and expenses related to our credit facility and legal, accounting, finance and management activities, which are not considered separate operating segments.

The following tables summarize the statements of operations by region of our wholly-owned consolidated properties for the three and six months ended June 30, 2012 and 2011 (in thousands):
 
For the three months ended June 30, 2012
 
 
 
Honolulu
 
Western U.S.
 
Corporate
 
Total
Revenue:
 
 
 
 
 
 
 
Rental
$
5,808

 
$

 
$
4

 
$
5,812

Tenant reimbursements
4,001

 

 

 
4,001

Property management and other services

 

 
114

 
114

Parking
1,440

 

 

 
1,440

Other
109

 

 
26

 
135

Total revenue
11,358

 

 
144

 
11,502

Expenses:
 

 
 
 
 

 
 

Rental property operating
7,272

 

 

 
7,272

General and administrative

 

 
572

 
572

Depreciation and amortization
2,937

 

 

 
2,937

Interest
4,314

 

 
693

 
5,007

Total expenses
14,523

 

 
1,265

 
15,788

Loss from continuing operations before equity in net earnings of unconsolidated joint ventures
(3,165
)
 

 
(1,121
)
 
(4,286
)
Equity in net earnings of unconsolidated joint ventures

 

 
22

 
22

Net loss from continuing operations
(3,165
)
 

 
(1,099
)
 
(4,264
)
Discontinued operations:
 
 
 
 
 
 
 
Income from discontinued operations before gain on sale of property
542

 

 

 
542

Gain on sale of property
5,365

 

 

 
5,365

Income from discontinued operations
5,907

 

 

 
5,907

 
 
 
 
 
 
 
 
Net income (loss)
$
2,742

 
$

 
$
(1,099
)
 
1,643

Net income attributable to non-controlling interests
 

 
 
 
 

 
(1,066
)
Dividends on Senior Common Stock
 

 
 
 
 

 
(438
)
Net income attributable to common stockholders
 

 
 
 
 

 
$
139




27

Pacific Office Properties Trust, Inc.
Notes to Consolidated Financial Statements



 
For the six months ended June 30, 2012
 
 
 
Honolulu
 
Western U.S.
 
Corporate
 
Total
Revenue:
 
 
 
 
 
 
 
Rental
$
11,646

 
$

 
$
24

 
$
11,670

Tenant reimbursements
7,991

 

 

 
7,991

Property management and other services

 

 
1,408

 
1,408

Parking
2,817

 

 

 
2,817

Other
166

 

 
157

 
323

Total revenue
22,620

 

 
1,589

 
24,209

Expenses:
 

 
 
 
 

 
 

Rental property operating
13,947

 

 

 
13,947

General and administrative

 

 
3,276

 
3,276

Depreciation and amortization
5,861

 

 

 
5,861

Interest
8,587

 

 
1,374

 
9,961

Total expenses
28,395

 

 
4,650

 
33,045

Loss from continuing operations before equity in net earnings of unconsolidated joint ventures
(5,775
)
 

 
(3,061
)
 
(8,836
)
Equity in net earnings of unconsolidated joint ventures

 

 
527

 
527

Net loss from continuing operations
(5,775
)
 

 
(2,534
)
 
(8,309
)
Discontinued operations:
 
 
 
 
 
 
 
Income from discontinued operations before gains on extinguishment of debt and sale of property
700

 

 

 
700

Gain on extinguishment of debt

 
2,251

 

 
2,251

Gain on sale of property
5,365

 

 

 
5,365

Income from discontinued operations
6,065

 
2,251

 

 
8,316

 
 
 
 
 
 
 
 
Net income (loss)
$
290

 
$
2,251

 
$
(2,534
)
 
7

Net loss attributable to non-controlling interests
 

 
 
 
 

 
430

Dividends on Senior Common Stock
 

 
 
 
 

 
(875
)
Net loss attributable to common stockholders
 

 
 
 
 

 
$
(438
)


28

Pacific Office Properties Trust, Inc.
Notes to Consolidated Financial Statements



 
For the three months ended June 30, 2011
 
 
 
Honolulu
 
Western U.S.
 
Corporate
 
Total
Revenue:
 
 
 
 
 
 
 
Rental
$
6,145

 
$
911

 
$
31

 
$
7,087

Tenant reimbursements
3,859

 
46

 

 
3,905

Property management and other services

 

 
1,591

 
1,591

Parking
1,425

 
81

 

 
1,506

Other
50

 
32

 
217

 
299

Total revenue
11,479

 
1,070

 
1,839

 
14,388

Expenses:
 

 
 

 
 

 
 

Rental property operating
6,821

 
664

 

 
7,485

General and administrative

 

 
3,067

 
3,067

Depreciation and amortization
3,112

 
348

 

 
3,460

Interest
4,329

 
324

 
684

 
5,337

Acquisition costs

 

 
68

 
68

Impairment on long-lived assets
5,049

 
6,407

 

 
11,456

Total expenses
19,311

 
7,743

 
3,819

 
30,873

Loss from continuing operations before equity in net loss of unconsolidated joint ventures
(7,832
)
 
$
(6,673
)
 
(1,980
)
 
(16,485
)
Equity in net loss of unconsolidated joint ventures

 

 
(1,490
)
 
(1,490
)
Net loss from continuing operations
(7,832
)
 
(6,673
)
 
(3,470
)
 
(17,975
)
Income (loss) from discontinued operations
72

 
(3,649
)
 

 
(3,577
)
Net loss
$
(7,760
)
 
$
(10,322
)
 
$
(3,470
)
 
(21,552
)
Gain on forgiveness of debt
 
 
 
 
 
 
10,045

Net loss attributable to non-controlling interests
 

 
 

 
 

 
9,243

Non-operating income
 
 
 
 
 
 
(17
)
Dividends on Senior Common Stock
 
 
 
 
 
 
(438
)
Net loss attributable to common stockholders
 

 
 

 
 

 
$
(2,719
)
 


29

Pacific Office Properties Trust, Inc.
Notes to Consolidated Financial Statements



 
For the six months ended June 30, 2011
 
 
 
Honolulu
 
Western U.S.
 
Corporate
 
Total
Revenue:
 
 
 
 
 
 
 
Rental
$
12,404

 
$
3,651

 
$
35

 
$
16,090

Tenant reimbursements
8,043

 
210

 

 
8,253

Property management and other services

 

 
2,353

 
2,353

Parking
2,941

 
323

 

 
3,264

Other
609

 
39

 
218

 
866

Total revenue
23,997

 
4,223

 
2,606

 
30,826

Expenses:
 

 
 

 
 

 
 

Rental property operating
13,754

 
2,328

 

 
16,082

General and administrative

 

 
5,634

 
5,634

Depreciation and amortization
6,299

 
1,418

 

 
7,717

Interest
8,905

 
1,450

 
1,353

 
11,708

Abandoned offering costs

 

 
420